Chapter 8 Concepts and Terms Flashcards
the interest rate
Savers (lenders) are paid for delaying consumption until the future, by borrowers, who wish to consume or invest more in the present and will later pay for that privilege - the price they pay is…
direct finance
a borrower deals directly with the lender, as Jen and Greg did, above. Businesses and governments who “sell bonds” to consumers, businesses, and governments, also are engaging in direct finance.
maturity
The date that the payment will be made to the lender
face value
The value paid at maturity
zero coupon bond
the seller makes no interest payments; all US government bonds and some corporate bonds
coupon rate
Many corporate bonds also make interest payments twice per year until maturity, so the bond above would also have an interest rate quoted on it
indirect finance
When individuals and businesses use middlemen, such as banks, for borrowing and lending, they are engaging in…
From Bastiat’s chapter 6, we learned that middlemen are paid because they add value. If they were useless, then no one would pay them. Just as in production, financial intermediaries, such as banks, are paid because they provide value to consumers and businesses. Imagine if you wished to save $10,000 and earn interest, but did not want to use a bank. You would encounter problems that a bank would have mitigated. Financial intermediaries such as banks,
• Spread the risk of non-payment. If you lend to a borrower, you may be repaid zero. But since banks make thousands of loans, most of which will pay, it is extremely unlikely that you will lose everything.
• Develop comparative advantages in credit evaluation and collection. If you advertised on Craigslist that you wanted to lend $10,000 you would likely have little way of evaluating potential borrowers. Also, if you loan to someone who does not repay, it will be expensive for you to take them to court to get the money back. But banks evaluate borrowers every day, have lawyers on retainer and have experience in getting borrowers to pay.
- Divide denominations of loans. You might find someone who wants to borrow $4,500 of your $10,000, then find someone who wants to borrow $8,000. Banks take deposits from many savers, pool them, and can lend different amounts, depending on the borrower.
- Match time preferences. You may wish to lend for 1 year, but find someone who wishes to borrow for 3 years—or for 6 months. Banks’ constant churning of deposits and loans match up savers’ and borrowers’ time preferences.
usury law
puts a price ceiling on interest rates, it would cause a shortage in the market if the ceiling was below the equilibrium interest rate
indirect crowding out
When an increase in government spending is financed through borrowing, private spending decreases due to rising interest rates
direct crowding out
when government spends, private markets spend less because their ability to spend is taxed away
leveraged buyout
where a firm borrows in order to purchase another firm, then immediately sells the firm in whole or in parts
insolvent
When firms cannot pay their obligations and cannot borrow more to pay, they may declare bankruptcy, triggering a legal proceeding. A firm whose value is negative—owes more than it owns
illiquid
when a solvent firm is forced to declare bankruptcy because it cannot pay its immediate obligations
absolute priority rule
the creditors are ranked with regard
to how long ago the company became indebted to them, then every penny is paid to the “senior” debt, before any less senior debt is paid. Then every penny is paid to the next senior debt class, and so on. The stockholders—the owners—are last on the list.
